trailing stop

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Trailing Stop

An order to sell a security when the price drops below a certain percentage of a given price. If the price rises, the trailing stop remains the same percentage below the new price. However, if the price drops, the trailing stop remains the same.

For example, suppose an investor buys a security at $10 per share and sets a trailing stop at 20% below the price. If the price drops to $8, the security is automatically sold. If the price rises to $20, the trailing stop moves to $16. However, if the security is bought at $10 and the price drops to $9.50, the trailing stop remains at $8. Likewise, if the price rises to $20 and then drops to $18, the new trailing stop remains $16. See also: Advisory account.

trailing stop

A stop order to sell (or to buy) a security in which subsequent stop orders are placed at progressively higher (or lower) levels as the stock price increases (or decreases). For example, an investor may purchase shares of Union Pacific Corporation at $60 and simultaneously place a stop order to sell the stock if it drops to $58 or below. If the stock rises to $63 without going through the $58 stop price, the investor raises the stop price to $61. Thus, the stop price trails the market price of the stock.

Previous studies such as Davidsson (2010) has shown that a trailing stop loss represent a natural tool for a trend following investor because as long as the trend is intact the trailing stop loss is not triggered.

A trend following strategy (conditional risk adjusted expected return) will have lower return volatility hence a trailing stop loss would be more appropriate to capture changes in expected returns.

We start by investigating a simple strategy where we take a long position in all stocks and where the exit point is done according to a trailing stop loss.

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